How to make ripped/torn cloth?
I would combine the two options above, and use use the V key to rip edges in edge select mode to outline the strips that will fall. I would still suggest alpha texture to get the edge roughing and then possibly look at the stuffed animal tutorial on CGCookie, using particles for the fuzzy stuff. Of course, the cloth sim would need to be rerun or manually unfold the strips. You might add some weight to the vertex group to make them hang.